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CostBasis.com


Bond Bought at a Discount

  Determining the cost basis of a bond
  or note bought at a discount from
  par value depends on two factors:
 
  (1)  whether it is TAXABLE or
       TAX-EXEMPT, and

  (2)  whether you held it until the
        maturity date or sold it prior to
        maturity (or it was called.)


     For each combination of factors, the answer is detailed below.  Page down until
     you see your particular situation:

     A.   If you bought a TAXABLE bond at a DISCOUNT and redeemed it at MATURITY:

     Your cost basis is par value, but to arrive at that result is a three-step process for
     individual investors:

     (1)  Determine the original purchase price per bond from the trade confirmation. 
     Do not include the accrued interest that you may have paid at the purchase date.
     You should have already deducted this on your Form 1040 Schedule B as a reduction
     of interest income in the year of purchase.

     (2)  Add any OID (original issue discount) interest which has been taxed to you on
     Form 1099 each year since you bought the bond. This is an increase in your cost
     basis because you paid tax on interest income which you will not receive until
     maturity.

     (3)  If the sum of steps (a) and (b) is less than par value, increase your cost basis
     to par value by taking the remaining difference and reporting it as taxable interest
     on your Form 1040 Schedule B in the year the bond matures.  This difference repre-
     sents the market discount which is really additional interest to you over the life of
     the bond.  It is not eligible for capital gains treatment and has to be reported as
     ordinary taxable interest income.

     B.  If you bought a TAX-EXEMPT bond at a DISCOUNT and redeemed it at MATURITY:
 
      Your adjusted cost basis is par value.
      
     C.   If you bought a TAXABLE bond at a DISCOUNT and sold it PRIOR to maturity:

      There are two possible answers in this case.  Examine the description of the
      bond on your original trade confirmation or on your monthly brokerage 
      account statement.  If the initials "OID" appear anywhere in the description,
      the bond was issued with an original issue discount and you should determine
      your cost basis by Method A.  If not, it is a "market discount" bond, and you
      should use Method B.

      Method A.  If the bond was issued with an original discount, first determine
      the original purchase price per bond from the trade confirmation.  Do not
      include the accrued interest that you may have paid at the purchase date. 
      You should have already deducted this on your Form 1040 Schedule B as a
      reduction of interest income.

      Add any OID (original issue discount) interest which has been taxed to you on
      Form 1099 each year since you bought the bond. This is an increase in your cost
      basis because you paid tax on interest income which you will not receive until
      maturity.

      Your cost basis is the original purchase price plus the accumulated OID.

      Method B.  If the bond was not issued with an original discount, first determine the
      original purchase price of the bond from the trade confirmation.  Do not include 
      the accrued interest that you may have paid at the purchase date.  You should
      have already deducted this on your Form 1040 Schedule B as a reduction of
      interest income.

      Next accrete the discount from the date of purchase to the date of sale using
      either the "
yield to maturity" method or the "ratable accrual" method (see menu
      at left for explanations.)  This discount accretion should all be reported as
      ordinary taxable interest income in the year of sale.  Alternatively, in the year of
      purchase, you could elect to report the discount accretion as additional taxable
      interest income each year over the life of the bond.

      Your cost basis is the original purchase price plus the accumulated discount
      accretion using either the "yield to maturity" method or the "ratable accrual"
      method (see menu items at left for detailed instructions on how to apply
      these methods.)    

      See below for our interactive tool to help you calculate your cost basis using
      the "yield to maturity" method.

     D.   If you bought a TAX-EXEMPT bond at a DISCOUNT and sold it PRIOR to maturity:

     Now it gets a lot more complicated.  Trust me, you want to hold your bonds to
     maturity if at all possible.  Not only do you avoid the cost of the sales commission
     and the bid/ask dealer spread, but you can also avoid the following accounting
     nightmare (unless you are truly a glutton for punishment.) 

     You are required to accrete the
     discount over the life of the
     tax-exempt note or bond to
     determine your cost basis using
     the "
Yield to Maturity" method.  See 
     menu at left for an explanation
     and example of how to do this.      

     Your cost basis is the original
     purchase price plus the
     accumulated discount 
     accretions using the
     "
yield to maturity" method.

              Click on the image below to
              access our handy interactive
           tool to calculate your cost basis
         using the "yield to maturity" method.

Amortization Table Generator
Amortization Table Generator



Information provided is intended solely for cash-basis U.S. citizen individual taxpayers and is believed to be accurate for most cases but is not guaranteed. Always consult your personal tax advisor about your own situation. Suggestions are most welcome. Please email our webmaster @ costbasis.com with your comments.   If this website has been helpful to you, please consider making a donation to support our efforts.

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What is the cost basis of my investment?